Market Weekly Update

The S&P 500 index is still on its way to build a “Domed House” with a short-term bullish time window until 1/17/2013. The market ratio and competitive strength show that international stock markets perform even better, especially with strength in European market led by the strong Greek stock market, as the euro outperforms the U.S. dollar. Contrary to popular expectations, Apple, gold and the Chinese stock market are extraordinarily lagging.

• Leading-Wave Index Continues Its Bullish Readings
• The S&P 500 Index in the “First Floor” Phase
• Market Ratio and Competitive Strength
• Gold is in the “Run” Phase of a Bump-and-Run Reversal Top Pattern
• Gold in a 3-Month Downtrend Channel
• Silver in a 3-Month Downtrend Channel
• Gold/Silver Mining Stocks Still in a 6-Month Uptrend Channel
• Crude Oil in a 7-Month Symmetrical Triangle
• US Dollar in a 4-Month Descending Triangle
• US Treasury Bond Weakening
• Asset Class Performance Ranking with Equity Leading
• Sector Performance Ranking with Home Construction Sector Leading
• BRIC Stock Market Performance Ranking with the Russian Market Leading

The Broad Market Instability Index (BIX), measured from over 8000 U.S. stocks, closed at 4 on Friday (up from 2 the previous week) which is below the panic threshold level of 44 and indicates a very bullish market. Since 11/19/2012, the Leading-Wave Index (LWX) has been steadily bullish for eight weeks. Based on the forecast of the LWX, the broad market should be in a short-term bullish time-window until 1/17/2013 (see the second table above). The daily chart of the Wilshire 5000 index below has the price bars color coded with the LWX indicator. The current market status is summarized as follows:

We have been tracking the current speculated “Three Peaks and a Domed House” pattern of the S&P 500 index for 11 weeks since my Weekly Update on 10/31/2012. The “Three Peaks and a Domed House” pattern is a complex chart formation, and it presents higher difficulties or challenges for a single technical indicator or system to handle the market throughout the entire pattern. It enhances risks and opportunities for both the bulls and bears.

In speaking of “the Three Peaks and a Domed House” pattern, my version modified from George Lindsay’s basic model uses a macro or “phase-counting” approach which is different from Lindsay’s original micro approach (which uses “wave-counting” from 1 to 28) in that it divides the “Three Peaks and the Domed House” pattern into five major phases as follows: 1) Three Peaks, 2) Basement, 3) First Floor, 4) Roof, and 5) Plunge.

The progressional development of the current speculated “Three Peaks and a Domed House” pattern is as follows:

Three Peaks phase: From mid-September to mid-October, the SPX formed three peaks in a trading range between 1430 and 1460 while the broad market was in the distribution stage of the market cycle. That was the earliest warning sign for a beginning of “Three Peaks and a Domed House” formation.

Separating Decline: From late October to mid-November, the SPX declined about 110 points from 1460 to 1350. Typically, this decline is a phase transition from the “Three Peaks” phase to the “Basement” phase, and corresponds to the mark-down stage of the market cycle. It usually moves much faster than general technical indicators can respond.

Basement phase: Around mid-November the SPX hit 4-month low near 1350 which was in the “Basement” phase. This phase is typically a “bear trap” near the bottom of a down cycle with a bearish market sentiment combining all bearish views from both headline news and popular technical indicators. The accumulation stage of the market cycle usually starts from here and it progresses stealthily.

Swift Advance: From mid-November to early January, the SPX sharply advanced about 110 points from 1350 to 1460. This advance is typically a phase transition from the “Basement” phase to the “First Floor” phase while the broad market continues the accumulation stage although the general sentiment is skeptical, or even still bearish.

First Floor phase: Boosted by the powerful advance during the first week of the year, the price range between 1440 and 1460 for the “First Floor” phase has been reached as projected. This phase is typically a consolidation in price movement. Currently the accumulation stage of the market cycle has ended with a change of the general market sentiment from bearish to neutral. As the “First Floor” phase matures, the mark-up stage could start immediately with another advance towards the “Roof” phase of the domed house.

Last week, I talked about how to gauge the “January Effect” by using the ratio the ratio of the Russell 2000 index of smaller companies divided by the Russell 1000 index of largest companies. Such a market ratio is very helpful to compare strengths between two different markets. The following table lists several pairs of markets, i.e., the euro vs. the US dollar, the Greek market vs. the Chinese market, the long-term rate vs. the short-term rate, the S&P 500 index vs. gold, small caps vs. large caps, the US market vs. the world market, and Apple vs. Research In Motion.

For each pair of markets listed in the table, the market ratio is calculated by dividing one market by another. Then the competitive strength is further evaluated from a percentage change of the ratio against its 89-day exponential moving average. The results divide the markets into two groups: outperforming markets and underperforming markets.

What can we conclude from this table? The results show a general market situation with strength in international stock markets, especially the bullish European market led by the strong Greek stock market as the euro outperforms the U.S. dollar. Contrary to popular expectations, gold, Apple, and the Chinese stock market are extraordinarily lagging.

Greek Market vs. Chinese Market: This year each week I am going to talk about one pair of markets in the table above. Following last week’s discussion on the market ratio of the Russell 2000 to the Russell 1000 relating to the “January Effect”, this time I focus on the stock markets of Greece and China. It is interesting to compare these two stock markets because they are in the two extreme economies of the world: the worst and the best.

The chart below is a daily chart in one-year horizon for the Athen Composite Index of Greece (blue), the Shanghai Composite Index of China (red) and their ratio (yellow). The chart shows:

A) Both of these two markets hit multi-year lows terribly during last year, the Year of the Water Dragon, regardless of their economies.

B) Both of them rebounded from their respective multi-year lows, 106% in the Greek market and 16% in the Chinese market. But only the Greek market made 52-week highs after its rebound.

C) The market ratio of Greece to China crossed over its 89-day exponential moving average in mid-summer of last year. Since then, the Greek market has gained significant competitive strength.

D) The market ratio currently is 15.79% above its 89-day exponential moving average, which indicates a relatively strong market of Greece and a relatively weak market of China, although popular feeling is still pessimistic about Greece’s economy and optimistic about China’s economy.

What we learned here is that the economy can go one way and the market can go another way. Sir John Templeton once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

The gold index has been in an intermediate-term Bump-and-Run Reversal Top pattern since I identified this pattern on gold in my article “How Low Can Gold Go on a Correction?” in August of 2011. Currently the gold price is below the “Lead-in Trendline” and it is in the “Run” phase. It is a bearish sign for gold with a breakdown from the support of the first target line at 1700. The next support could be at 1550 near the 2nd target line.

The gold index has formed a 3-month downtrend channel. Prices have recently tested the lower boundary of the channel twice. An upswing towards the upper boundary of the channel should be expected.

Same as gold, the silver index has formed a 3-month downtrend channel. Prices have recently tested the lower boundary of the channel twice. An upswing towards the upper boundary of the channel should be expected.

Gold/silver mining stocks are testing the lower boundary of the 6-month uptrend channel. Prices may bounce off the lower boundary of the channel from here.

Crude oil has formed a 7-month Symmetrical Triangle pattern. Prices may move in a converging range bounded between 86 and 94. Currently prices have reached the upper boundary at 94, and a pullback could be expected.

The US dollar index is in a 4-month Descending Triangle pattern, and the direction of a breakout from this triangle could be important to the next move of the dollar. Currently the dollar pulled back from the upper boundary of the triangle.

Considering the current deflationary environment indicated by the inflation rate below 3%, bonds have an inverse relationship with stocks. Strengthening in stocks means weakening in bonds. The 30-year U.S. treasury bond has recently broken a 2-year rising wedge pattern to the downside. A price target could be projected at 134.

The following table is the percentage change of each asset class (in ETFs) against the 89-day exponential moving average (EMA89). Currently equity is outperforming, and the U.S. treasury bond is underperforming.

The following table is the percentage change of sectors and major market indexes against the 89-day exponential moving average (EMA89). The Dow Jones Wilshire 5000 index, as an average or a benchmark of the total market, is 4.23% above the EMA89. Outperforming sectors are Home Construction (10.21%), Internet (8.09%), and Banks (8.02%). Underperforming sectors are Precious Metals (-4.47%), Utilities (0.02%), and Telecommunication (0.15%). The Russell 2000 small-cap is outperforming and the NASDAQ 100 is underperforming.

The table below is the percentage change of the BRIC stock market indexes against the 89-day exponential moving average (EMA89), also in comparison to the US market. Currently the Russian market is leading, and all BRIC markets are outperforming the US market.